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The next time you go shopping, hold on to your receipts. It will make it a lot easier to return those leopard-skin pants you purchased in a moment of midlife madness. And even if you decide to keep the pants, the receipt may help you lower your tax bill. A corporate tax bill approved by Congress last week gives taxpayers who itemize the choice of deducting state and local sales taxes or state income taxes on their federal tax returns. The bill is expected to be signed by President Bush.

The biggest beneficiaries of the change will be residents of states with no income tax. While states without an income tax typically raise more of their revenue from sales taxes, residents haven’t been allowed to deduct those taxes. Supporters of the new deduction say that’s unfair.
NEWLY DEDUCTIBLE

States that have sales tax and no income tax:

Alaska
Florida
Nevada
South Dakota
Tennessee1
Texas
Washington
Wyoming

1 - State income tax is limited to dividends and interest income. Note: New Hampshire has no income or sales tax.
Source: Federation of Tax Administrators

Starting this year, residents of those states will be permitted to add sales taxes to other deductions, such as charitable contributions and interest on home mortgages.

“Anybody who itemizes deductions in those states is going to like this provision,” says Mel Schwarz, tax legislative affairs director for Grant Thornton.

But you don’t have to live in Texas or Nevada to benefit from the sales tax deduction. Some taxpayers who live in states with income taxes may reap a bigger tax break by deducting sales taxes instead. Instances in which the sales tax deduction could offer a better deal:

• You live in a state with low income taxes and high sales taxes.

Illinois, for example, has a 3% income tax and a state sales tax rate of 6.25%. Depending on your income and how much you spend, you may get a bigger tax break by deducting your sales taxes than your state income taxes, says John Roth, analyst at tax publisher CCH.

• You’re a senior citizen.

If most of your income comes from U.S. government securities, you probably don’t pay much in state income taxes because the interest is exempt from state taxes, says Tom Ochsenschlager, vice president of taxation for the American Institute of Certified Public Accountants. Deducting sales taxes may provide a bigger tax break.

Some states allow seniors to exclude a larger amount of their income from state taxes, reducing their state tax bill, Schwarz says. Seniors in those states who itemize may also get a larger deduction from sales taxes, he says.

• There’s a new car in your driveway.

Taxpayers who deduct their sales taxes will have a choice of two methods to calculate their deduction. You can deduct the actual amount of your sales taxes, which means holding on to sales receipts in case of an audit. Alternatively, you can use IRS tables that will assign an amount based on adjusted gross income, dependents, filing status and state of residence.

But if you bought a car or boat, you’ll be allowed to deduct the amount listed in the IRS tables, plus the actual sales tax you paid on the purchase. For example, if the IRS tables allow you to deduct $300 and sales taxes on your new boat total $500, you’ll be allowed to deduct $800 in sales taxes. If you pay less than that in state income taxes, deducting your sales taxes will provide a greater tax savings.

The law states the special treatment will be extended to “other items” to be determined by the Treasury Department. Those items will likely include other big-ticket purchases, such as airplanes and major appliances, Roth says.

What to do now

Unfortunately, this new tax wrinkle came along late in the year. Unless you’re a serious pack rat, you probably haven’t saved receipts for all your purchases this year. For that reason, many taxpayers will probably find it easier to use the IRS tables when calculating the sales tax deduction on their 2004 tax returns. Those tables aren’t expected to be released until next year.

However, there are a couple of steps you can take now that will help you take advantage of the new tax break:

• If you bought a car or boat this year, or plan to buy one before year’s end, hang on to your receipts so you can take advantage of the larger deduction available for those items. Chances are, you’ve saved those receipts anyway for warranty purposes, Roth says.

• Hang on to receipts for other potential deductions, such as year-end charitable contributions. About two-thirds of taxpayers take the standard deduction instead of itemizing. But allowing taxpayers to deduct sales taxes may increase the number of individuals who would benefit from itemizing, particularly in states with no income taxes, tax experts say.

If you’re close to the edge, adding sales tax to other common deductions could push you over the top, Ochsenschlager says.

Finally, don’t get too attached to this new tax break. The deduction is limited to 2004 and 2005. It will disappear in 2006 unless Congress decides to extend it.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.